Accounting Information Systems, 6th edition

James A. Hall

COPYRIGHT 2009 South-Western, a division of Cengage Learning. Cengage Learning and South-Western
are trademarks used herein under license

Business Ethics
Why should we be concerned about ethics in
the business world?
Ethics are needed when conflicts arisethe
need to choose
In business, conflicts may arise between:
employees
management
stakeholders

Litigation

Business Ethics
Business ethics involves finding the answers to two
questions:
How do managers decide on what is right in
conducting their business?
Once managers have recognized what is right, how do
they achieve it?

Four Main Areas of Business Ethics

Computer Ethics
concerns the social impact of computer technology (hardware,
software, and telecommunications).
What are the main computer ethics issues?
Privacy
Securityaccuracy and confidentiality
Ownership of property
Equity in access
Environmental issues
Artificial intelligence
Unemployment and displacement
Misuse of computer

Legal Definition of Fraud

False representation - false statement or

disclosure
Material fact - a fact must be substantial in
inducing someone to act
Intent to deceive must exist
The misrepresentation must have resulted in
justifiable reliance upon information, which
caused someone to act
The misrepresentation must have caused
injury or loss

Factors that Contribute to

Fraud

2004 ACFE Study of Fraud

Loss due to fraud equal to 6% of revenues
approximately $660 billion
Loss by position within the company:

Other results: higher losses due to men,

employees acting in collusion, and employees
with advance degrees

Enron, WorldCom, Adelphia

Underlying Problems
Lack of Auditor Independence: auditing firms also engaged by their

clients to perform nonaccounting activities

Lack of Director Independence: directors who also serve on the boards
of other companies, have a business trading relationship, have a
financial relationship as stockholders or have received personal loans,
or have an operational relationship as employees
Questionable Executive Compensation Schemes: short-term stock
options as compensation result in short-term strategies aimed at
driving up stock prices at the expense of the firms long-term health.
Inappropriate Accounting Practices: a characteristic common to many
financial statement fraud schemes.
Enron made elaborate use of special purpose entities
WorldCom transferred transmission line costs from current expense
accounts to capital accounts

Sarbanes-Oxley Act of 2002

Its principal reforms pertain to:
Creation of the Public Company Accounting

Oversight Board (PCAOB)

Auditor independencemore separation between a
firms attestation and non-auditing activities
Corporate governance and responsibilityaudit
committee members must be independent and the
audit committee must oversee the external auditors
Disclosure requirementsincrease issuer and
management disclosure
New federal crimes for the destruction of or
tampering with documents, securities fraud, and
actions against whistleblowers

Employee Fraud
Committed by non-management personnel

Usually consists of: an employee taking cash or other

assets for personal gain by circumventing a companys

system of internal controls

Management Fraud
Perpetrated at levels of management above the

one to which internal control structure relates

Frequently involves using financial statements to
create an illusion that an entity is more healthy
and prosperous than it actually is
Involves misappropriation of assets, it frequently
is shrouded in a maze of complex business
transactions

Fraud Schemes
Three categories of fraud schemes according to the
Association of Certified Fraud Examiners:

A. fraudulent statements
B. corruption
C. asset misappropriation

A. Fraudulent Statements
Misstating the financial statements to make the copy

appear better than it is

Usually occurs as management fraud
May be tied to focus on short-term financial measures
for success
May also be related to management bonus packages
being tied to financial statements

B. Corruption
Examples:
bribery
illegal gratuities
conflicts of interest
economic extortion
Foreign Corrupt Practice Act of 1977:
indicative of corruption in business world
impacted accounting by requiring accurate records and
internal controls

C. Asset Misappropriation
Most common type of fraud and often occurs as

employee fraud
Examples:
making charges to expense accounts to cover theft of

asset (especially cash)

lapping: using customers check from one account to
cover theft from a different account
transaction fraud: deleting, altering, or adding false
transactions to steal assets

Computer Fraud Schemes

Theft, misuse, or misappropriation of assets by

altering computer-readable records and files

Theft, misuse, or misappropriation of assets by
altering logic of computer software
Theft or illegal use of computer-readable
information
Theft, corruption, illegal copying or intentional
destruction of software
Theft, misuse, or misappropriation of computer
hardware

Using the general IS model, explain how fraud can

occur at the different stages of information processing?

Data Collection Fraud

This aspect of the system is the most vulnerable

because it is relatively easy to change data as it is being

entered into the system.
Also, the GIGO (garbage in, garbage out) principle
reminds us that if the input data is inaccurate,
processing will result in inaccurate output.

Data Processing Fraud

Program Frauds

altering programs to allow illegal access to and/or

manipulation of data files
destroying programs with a virus
Operations Frauds
misuse of company computer resources, such as
using the computer for personal business

Database Management Fraud

Altering, deleting, corrupting, destroying, or stealing

an organizations data
Oftentimes conducted by disgruntled or ex-employee

Information Generation Fraud

Stealing, misdirecting, or misusing computer output
Scavenging
searching through the trash cans on the computer
center for discarded output (the output should be
shredded, but frequently is not)

Internal Control Objectives

According to AICPA SAS
1. Safeguard assets of the firm
2. Ensure accuracy and reliability of accounting

records and information

3. Promote efficiency of the firms operations
4. Measure compliance with managements
prescribed policies and procedures

Modifying Assumptions to the Internal

Control Objectives
Management Responsibility
The establishment and maintenance of a system of internal
control is the responsibility of management.

Reasonable Assurance
The cost of achieving the objectives of internal control should
not outweigh its benefits.

Methods of Data Processing

The techniques of achieving the objectives will vary with
different types of technology.

Limitations of Internal Controls

Possibility of honest errors
Circumvention via collusion
Management override

Changing conditions--especially in companies with

high growth

Exposures of Weak Internal

Controls (Risk)
Destruction of an asset
Theft of an asset

Corruption of information
Disruption of the information system

The Internal Controls Shield

Preventive, Detective, and Corrective

Controls

SAS 78 / COSO
Describes the relationship between the firms
internal control structure,
auditors assessment of risk, and
the planning of audit procedures
How do these three interrelate?

The weaker the internal control structure, the higher the

assessed level of risk; the higher the risk, the more auditor
procedures applied in the audit.

Five Internal Control

Components: SAS 78 / COSO
1. Control environment
2. Risk assessment
3. Information and communication
4. Monitoring
5. Control activities

1: The Control Environment

Integrity and ethics of management
Organizational structure
Role of the board of directors and the audit
committee
Managements policies and philosophy
Delegation of responsibility and authority
Performance evaluation measures
External influencesregulatory agencies
Policies and practices managing human
resources

2: Risk Assessment
Identify, analyze and manage risks relevant to

financial reporting:
changes in external environment
risky foreign markets
significant and rapid growth that strain internal

controls
new product lines
restructuring, downsizing
changes in accounting policies

3: Information and Communication

The AIS should produce high quality information

which:
identifies and records all valid transactions
provides timely information in appropriate detail to

permit proper classification and financial reporting

accurately measures the financial value of transactions
accurately records transactions in the time period in
which they occurred

Information and Communication

Auditors must obtain sufficient knowledge of the IS to

understand:
the classes of transactions that are material

how these transactions are initiated [input]

the associated accounting records and accounts used in
processing [input]

the transaction processing steps involved from the

initiation of a transaction to its inclusion in the financial

statements [process]
the financial reporting process used to compile financial
statements, disclosures, and estimates [output]
[red shows relationship to the general AIS model]

4: Monitoring
The process for assessing the quality of internal control
design and operation
[This is feedback in the general AIS model.]
Separate procedurestest of controls by internal auditors
Ongoing monitoring:
computer modules integrated into routine operations
management reports which highlight trends and
exceptions from normal performance

[red shows relationship to the general AIS model]

5: Control Activities
Policies and procedures to ensure that the appropriate

actions are taken in response to identified risks

Fall into two distinct categories:
IT controlsrelate specifically to the computer

environment
Physical controlsprimarily pertain to human activities

Two Types of IT Controls

General controlspertain to the entitywide

computer environment
Examples: controls over the data center, organization

databases, systems development, and program

maintenance

Application controlsensure the integrity of

specific systems
Examples: controls over sales order processing, accounts

payable, and payroll applications

Six Types of Physical Controls

Transaction Authorization
Segregation of Duties
Supervision

Accounting Records
Access Control
Independent Verification

Physical Controls
Transaction Authorization
used to ensure that employees are carrying out only

authorized transactions
general (everyday procedures) or specific (nonroutine transactions) authorizations

Physical Controls
Segregation of Duties
In manual systems, separation between:
authorizing and processing a transaction
custody and recordkeeping of the asset

subtasks

In computerized systems, separation between:

program coding

program processing
program maintenance

Physical Controls
Supervision
a compensation for lack of segregation; some may

be built into computer systems

Accounting Records
provide an audit trail

Physical Controls
Access Controls
help to safeguard assets by restricting physical

access to them

Independent Verification
reviewing batch totals or reconciling subsidiary

accounts with control accounts

Nested Control Objectives for

Transactions
Control
Authorization
Objective 1

Control
Authorization
Objective 2

Processing

Custody

Recording

Custody
Control
Authorization
Objective 3

Task 1

Recording

Task 2

Task 1

Task 2

Physical Controls in IT Contexts

Transaction Authorization
The rules are often embedded within computer

programs.
EDI/JIT: automated re-ordering of inventory without

human intervention

Physical Controls in IT Contexts

Segregation of Duties
A computer program may perform many tasks that are

deemed incompatible.
Thus the crucial need to separate program development,
program operations, and program maintenance.

Physical Controls in IT Contexts

Supervision
The ability to assess competent employees becomes

more challenging due to the greater technical

knowledge required.

Physical Controls in IT Contexts

Accounting Records
ledger accounts and sometimes source documents are

kept magnetically
no audit trail is readily apparent

Physical Controls in IT Contexts

Access Control
Data consolidation exposes the organization to computer

fraud and excessive losses from disaster.

Physical Controls in IT Contexts

Independent Verification
When tasks are performed by the computer rather than

manually, the need for an independent check is not

necessary.
However, the programs themselves are checked.